Sunday, 4 October 2009

Economic Principles that Work

I have had discussions with various friends about broad-brush Economic philosophies such as "Capitalism" and "Socialism", and we have agreed that these labels are largely meaningless because different people understand them to mean quite different things.

We then talked about "goals" being more important than "isms", but again, different people may believe in different goals for a society. For example, is it more important to first eliminate poverty (through government intervention if required) or to set up a functioning market economy without distortions?

The discussions seemed to be getting nowhere, so I decided to take a leaf from the book by Al Ries and Jack Trout, a book called "Bottom-Up Marketing." In it, the authors argue that rather than start with a grand strategy and derive tactics from it, the most successful military and business ventures have taken successful tactics and built strategies around it. The German strategy of Blitzkrieg was based on the observed capabilities of the armoured tank and of newly-improved radio communication. It was not a strategy derived from blue-sky thinking.

Perhaps in similar fashion, we can find examples of economic principles (shorn of ideological "isms") that work, and these can be put together into a coherent economic policy for a country. I admit that I have cheated a bit. I'm fortunate to be living in a country (Australia) that has enjoyed about 20 years of uninterrupted growth even as the rest of the world has undergone boom and bust cycles. The two striking features of the Australian economy are a near-constant budget surplus throughout this period, and a stated policy by the independent Reserve Bank of Australia to manage interest rates so as to keep inflation in the range of 2-3%. So finding economic principles that work has been largely a matter of describing the features of the Australian economy, but of course it wasn't just that.

So here goes. This is my list of principles, some of which have been proven to work, some of which could work under certain conditions, and some of which have been discredited. Obviously this has serious biases. It's my opinion, after all ;-).

1. Principles that are known to work and should no longer be controversial:

Principle: Prudence
Lay description: Don't spend more than you earn.
Label(s): "Fiscal conservatism"
Features: A balanced or surplus government budget, cost/benefit analysis of projects, sound project management
Notes: The Australian federal budget has been in surplus for many years until the fiscal stimulus of 2008-2009 and is projected to be back in surplus by 2014-2015.

Principle: Accountability
Lay description: (1) No one is above the law. (2) Deliver results to stakeholders, or else.
Label(s): "Democracy", "Rule of law"
Features: Institutionalised checks and balances, regular elections, power of recall, strong opposition, independent judiciary

Principle: Transparency
Lay description: Eliminate corruption, build faith in the system.
Label(s): "Transparency"
Features: Formal processes, Right-to-Information laws, office of auditor-general/public ombudsman, free press, legislative review

Principle: Market efficiency
Lay description: Ensure that no buyer or seller (or small group thereof) can skew the market.
Label(s): "Free market", "Liquid market", "Competitive market", "Efficient market"
Features: Competition watchdog (with teeth), strong antitrust law
Notes: Perhaps this is the one area where the Australian economy is wanting. The lack of competition in the banking sector is only just being realised and discussed. At the same time, the telecom monopoly is finally being addressed and will hopefully be dismantled.

Principle: Stable growth
Lay description: A central bank manages interest rates to contain inflation in the 2-3% band.
Label(s): "Responsive monetary policy"
Features: Independent central bank, stated inflation target
Notes: This focus of the Reserve Bank of Australia (RBA) together with a near-constant budget surplus has delivered 20 years of consistent growth even during periods of global recession.

Principle: Risk management
Lay description: Systems to identify and protect against various kinds of risks (mainly economic).
Label(s): "Diversification", "Risk regulation"
Features: Markets with breadth and depth, multi-skilled workforce, demographic diversity, risk management regulation, culture of risk management
Notes: There are many aspects to risk management, but its existence is generally a hallmark of a sophisticated economy.

Principle: Basic education
Lay description: Compulsorily educate all children.
Label(s): "Compulsory universal primary schooling"
Features: Fee-free public schooling upto and often including high school
Notes: All children must be afforded at least primary education, because literacy and numeracy are life skills and uneducated adults are a cost to society.

2. Principles that are controversial but can work provided they don't violate the first set:

Principle: A fair society
Lay description: This is one of the most misunderstood and variously interpreted principles, attracting a number of labels depending on the aspect being highlighted or criticised.
Label(s): "Meritocracy", "Affirmative action", "Equal opportunity", "Welfare state", "Social Security", "Egalitarianism"
Features: Constitution, bill of rights, independent judiciary, unemployment benefits, universal healthcare, tolerant society
Notes: As long as the budget stays balanced, these need not have downsides.

Principle: A skilled workforce
Lay description: Working age people have skills of a high quality that are productive in the economy.
Label(s): "Knowledge society",
Features: Universities, polytechnics, culture of higher education, incentives for higher education
Notes: Higher and technical education help a nation compete, but should not come at the cost of a deficit budget.

Principle: A healthy populace
Lay description: Affordable health care (prevention as well as treatment) for all.
Label(s): "Welfare state", "Universal healthcare", "Socialised medicine"
Features: Various mechanisms - single payer, compulsory private insurance, Medicare, etc.
Notes: Universal healthcare is an emotive issue, but should not be sought at the cost of a deficit budget. Prudence pays better long-term dividends.

Principle: A world market
Lay description: Free trade based on the principle of comparative advantage of nations.
Label(s): "Free trade"
Features: Low tariffs, low administrative/bureaucratic barriers to trade
Notes: Governments need to ensure both competitive/liquid markets and adequate diversification to maximise gains and reduce risk.

Principle: A regulated economy
Lay description: Government intervention in the functioning of the economy through a variety of mechanisms.
Label(s): "Mixed economy", "Public sector"
Features: Government ownership of enterprises, regulation of commercial activity (antitrust, price-setting for utilities, etc.)
Notes: Often criticised by advocates of a "free market" (itself a vague term), government intervention, if done well, can aid market liquidity by keeping commercial players honest, and can also provide much-needed services not provided by commercial players.

Principle: Wealth creation
Lay description: Tax incentives that benefit the well-off rather than those of more modest means.
Labels: "Supply-side economics", "Tax breaks for the rich", "Regressive taxation"
Features: Relatively low tax rates, modestly progressive tax slabs, tax-deductibility of investments, high income disparities
Notes: Taxation can often be a disincentive to wealth creation, but winding back taxation should not result in a deficit budget.

3. Principles that sound great but are observed not to work in practice:

Principle: Job security
Lay description: Legalised protection of jobs.
Label(s): "Socialism", "Protectionism", "Trade unionism"
Features: Strong trade unions, strict labour laws, no hire-and-fire, high import tariffs, tight immigration controls
Notes: Minimising unemployment has instinctive appeal, but the goal may be better reached by focusing on other targets, e.g., low inflation. The direct approach often has the opposite effect.

Principle: Unregulated markets
Lay description: Government stays out of the market altogether.
Label(s): "Capitalism", "Free market", "Laissez-faire economy", "Libertarianism", "Small government", "Monetarism"
Features: Limited government interference/intervention, unchecked market distortions (oligopolies and monopolies)
Notes: Recent failures in several economies with unregulated markets have shown the folly of this principle. Some regulation seems to be necessary, especially around keeping markets open and competitive and subject to risk management discipline.

Principle: Equality (as opposed to equal opportunity)
Lay description: Ensure that incomes, lifestyles, etc., are not too divergent.
Labels: "Socialism", "Communism", "Classless society", "Egalitarianism", "Tall poppy syndrome"
Features: Disincentives to wealth-building, limited private ownership, demonisation of "elites"
Notes: Fairness and equality of opportunity are more pragmatic principles that lead to an egalitarian society, where even the lowest-paid have an adequate standard of living to maintain their dignity and all have equal rights. Force-fitting an entire society into a mould of artificial equality only succeeds in making everyone equally poor, as the example of the communist countries has shown.

That's the lot, as far as I can tell. The question I have for the rest of the world is, if Australia can do it, why can't you?

Post a Comment